ECO401- Final Term Subjective

ECO401- Final Term Subjective Current Paper 20 July 2013 What is meant by non price competition? Non price competition means competition amongst the firms based on factors other than price, e.g. advertising expenditure, product differentiation etc What is meant by exchange rate? Also give example of exchange rate The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. For example, the higher the exchange rate for one Dollar in terms of one r=rupee, the lower the relative value of the Rupee Exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) Why government needs to revalue its currency? 1 P a g e

Revaluation of Currency is the act of increasing the price (exchange rate) of one nation's currency in terms of other currencies. Government revalues its currency to raise the price of the country's exports and lower the price of foreign imports. Procedure for revaluation is for the government to buy the nation's currency and/or sell foreign currencies through the foreign exchange market. Write the key variables for macro economic model The key variables for a macroeconomic model are: Y = Income C = Consumption S = Savings I = Investment T = Taxes G = Government Expenditures M = Imports X = Exports Circular flow of goods and income for firms and households Circular flow of income describes the movement of money throughout the economy between producers and consumers. It is a continuous flow of production, income and expenditures. Circular flow of income producers receive the amount what consumers spend. All expenditures from consumers/individuals become the income of the producers, and the expenditures of the producers become the income of the consumers/individuals. What is the reason of poverty in developing countries according to Prebisch-Singer hypothesis? 3 - Marks Reason of poverty in developing countries according to Prebisch-Singer hypothesis They were stuck in the production of primary products Lack of human, social and public capital Very fast rising populations Lack of natural resources (like oil, gold, gas, iron, copper etc.) 2 P a g e

Discuss the components on the assets and liabilities side of the balance sheet of a central bank Assets side of SBP s balance sheet, (1) The country s foreign exchange reserves (foreign currencies, gold and silver reserves; either held domestically or invested abroad) (2) Credit to government: this would include any SBP lending to government, including in the form of any outstanding (i.e. yet to mature) treasury bonds and bills lying with the SBP (3) Credit to banks: this would include any advances (another name for loans) extended by SBP to commercial banks. Liabilities side of SBP s balance sheet, 4) Notes and coins in circulation (i.e. M0). Note that for a currency-issuer (SBP in our case), the currency is a liability, not an asset; (5) Government or banks deposits: these would include any positive account6 balances held by commercial banks and/or the government; (6) Outstanding liquidity paper issued: this would include any bills issued by the central bank for the purpose of mopping up liquidity from the financial system. PAST SUBJECTIVE Why Marginal Revenue and price are equal under perfect competition? In perfect competition a firm that changes the quantity they sell does not affect price, therefore marginal revenue is equal to price. On what factors steady state growth rate of real GDP depends? (3) The steady-state growth rate of real GDP depends on n and t, the exogenous rates of growth of population and technology When does real wage unemployment occur in an economy? (3) Classical or real-wage unemployment occurs when real wages for a job are set above the market-clearing level. This is often as a result of government intervention, as with the minimum wage, or unions 3 P a g e

MPC = 0.84 and tax rate = 0.27 then find tax-adjusted multiplier Tax multiplier = 1/ (1- MPC (1 t)) Tax multiplier = 1/ (1-0.84 (1 0.27)) Tax multiplier = 1/ (0.16 (0.73) Tax multiplier = 1/ 0.1168 Tax multiplier = 8.57 Difference between Residential Investment and Inventory Investment Residential investment includes the purchase of new housing both by people who plan to live in it themselves and by landlords who plan to rent it to others. Inventory investment, the goods that businesses put aside in storage, is at the same time negligible and of great significance. Fiscal policy under flexible exchange rate With flexible exchange rates, the output level is determined in the money market where the interest rate is set equal to the world interest rate. Any change in government policy will only affect the exchange rate. Make balance sheet of central bank Balance sheet of SBP Assets Forex reserves Loans/Credit to Govt Loans/Credit to private sector Balance sheet of SBP Liabilities Notes, coins & currency in circulation: M0 Govt & commercial bank deposits Liquidity paper issued Discuss the concept of accelerator in your own words The accelerator is a reverse concept of multiplier which formalizes the investment response to output or income changes in an economy. When an economy begins to recover from a slump, investment can rise very rapidly and, in percentage terms, the rise in investment may be several times the rise in income. Since investment is an injection into the circular flow of income, these 4 P a g e

changes in investment will cause multiplied changes in income and thus heighten a boom or deepen a recession. The formula for the accelerator is = I/( Y), or ( K)/( Y) Define fiscal policy The Government income and expenditures policy is known as fiscal policy Differentiate between expansionary and contractionary fiscal policy Expansionary fiscal policy: An increase in government spending and decrease in taxes is called expansionary fiscal policy. According to policy higher government spending /decrease tax will increase aggregate demand. Its simply the increase in government spending and reduce taxes. Contractionary fiscal policy A decrease in government spending and increase in taxes is called contractionary fiscal policy. An active policy tries to stabilize output by using monetary and/or fiscal policy. A passive policy does not. Its simply the increase in taxes and reduce government spending Question No: 49 ( Marks: 3 ) It is said that growth is an important macroeconomic issue. Why? Discuss. Growth is an important macroeconomics issue because every country wants to achieve higher growth rate. Higher growth rate indicates the better living standards and high national income. Growth can be attained through trade e.g. a developing country who have specialization in a good and also have comparative advantage. By exporting these goods developing country can increase its national income and also attract foreign investment. Question No: 52 ( Marks: 5 ) 5 P a g e

Following figure shows the circular flow of goods and income in a two sector economy. Interpret all the points in this figure that how the household sector and business sector work in an economy to produce goods and services. Circular Flow of Goods and Income Factors of Production Wages Interest rate Rent Dividends FIRMS Consumer Expenditure Goods and Services HOUSEHOLDS Circular flow of income describes the movement of money throughout the economy between producers and consumers. It is a continuous flow of production, income and expenditures. Circular flow of income producers receive the same amount what consumers spend. All expenditures from consumers/individuals become the income of the producers, and the expenditures of the producers become the income of the consumers/individuals. Question No: 53 ( Marks: 5 ) Explain the difference between current account and capital account. Current Account: Current account is one of the two components of balance of payments. Current account shows the difference between a nation's total exports of goods, services and transfers, and its total imports. Capital Account: The capital account generally provides a direct picture of the net asset position of a country visà-vis the rest of the world. The capital account contains foreign direct investment (FDI), portfolio 6 P a g e

investment and other investments, plus changes in the reserve account. The capital account and the current account together comprise a nation's balance of payments. Question No: 57 ( Marks: 5 ) Some economists suggest growth through resource transfer and growth through stabilization and reforms strategies to tackle the problem of poverty of under developed countries. What is the basic theme of both these strategies? Discuss. Answer : Growth through resource transfer strategy states that money funds should be given to poor countries and this money should also be utilized properly. Through this process, private capital flows and foreign direct investment can also be made. When foreign firms came in the local market, they will bring skill and capital with themselves which will promote local market. But the problem with this strategy is that aid flows causes heavy debt burden for the poor countries. Growth through stabilization and reforms strategy states that there should be privatization and liberalization policies adopted in developing countries. Good governance and administrative reforms should be implemented. International Monetary Fund (IMF) and the World Bank (WB) became involved in macroeconomic stabilization and structural reform. Question No: 56 ( Marks: 5 ) Explain the difference between Gross National Product (GNP) and Net National Product (NNP) with the help of their formulas. Gross National Product (GNP) Gross national product (GNP) is the value, at current market prices, of all final goods and services produced during a year by the factors owned by the citizens of a country GNP = GDP + Net factor incomes from abroad Net National Product (NNP) Mathematically, national income is net national product (NNP). It is GNP adjusted for depreciation. NNP = GNP Depreciation allowance 7 P a g e

According to the values given in the following table, calculate the injections at each level of output. Output (Y) Saving (S) Gross Imports (M) Gross investment (I) Gross exports (X) Govt. Expenditures (G) Taxes (T) 650 80 80 104 97 116 10 700 90 80 119 97 116 10 750 100 80 130 97 116 10 800 110 80 139 97 116 10 900 120 80 146 97 116 10 Withdrawal = Injection S + T + M = I + G + X Injection = I + G + X Injection =104+116+97 = 317 Injection =119+116+97 =332 Injection =130+116+97 = 343 Injection =139+116+97 =352 Injection =146+116+97 = 359 Total injection =1403 Question No: 51 ( Marks: 5 ) Why is taxation necessary? What are the principles of taxation? Taxation is necessary because government collects taxes are to get the revenue needed to finance public goods and pay administrative expenses. Without taxes, the government would not be able to deliver services like law and order, public administration, national defense, free or subsidized health and education etc Equity principle Equity represents that principle of taxation which emphasizes fairness or just sacrifice, i.e. everyone should pay tax according to his/her ability Vertical equity principle 8 P a g e

Progressive taxation, in which the tax rate increases as income increases, is an application of the vertical equity principle Horizontal equity principle A less controversial principle relates to horizontal equity which says: identically well-off people should be taxed identically, i.e. no discrimination due to race, gender, caste, religion etc. Interest parity condition a) What is interest parity condition? Interest parity shows the relationship between the currency exchange rates of two countries and their local interest rates, and the essential role that it plays in foreign exchange markets. b) When does this condition hold? This condition holds if there are no incentives to move the capital from one country to another country as the difference between them c) What is the equation of this condition? id if + ΔEe Domestic interest rate = Foreign interest rate + Expected depreciation Question No: 55 ( Marks: 3 ) What are the different components of aggregate demand? Discuss briefly Aggregate demand (AD) is the total planned or desired spending (expenditure) in the economy during a given period. Components of AD are: consumption, investment, government spending and net exports (i.e. exports minus imports) From the information given in the following table, calculate the number of unemployed persons and unemployment rate. Year Size of Labor Force Number of persons Employed 1984 113544 105005 1985 115461 107150 1986 117834 109597 1987 119865 112440 9 P a g e

1988 121669 114968 Unemployed person Unemployed person in 1984 = 113544-105005 =8539 Unemployed person in 1985 = 115461-107150 =8311 Unemployed person in 1986 = 117834-109597 =8237 Unemployed person in 1987 = 119865-112440 =7425 Unemployed person in 1988 = 121669-114968 =6701 Unemployment rate Unemployment rate = (Number of unemployed / labour force) x 100 1984 = 8539/113544 x 100 =7.5% 1985= 8311/115461 x 100 =7.2% 1986=8237/117834 x 100 =6.9% 1987=7425/119865 x 100= 6.1% 1988=6701/121669 x 100 =5.5% 10 P a g e

Question No: 57 ( Marks: 5 ) Differentiate between final goods and intermediate goods with the help of examples. Final goods Final goods are meant for direct use by the end consumer rather than for further processing. Example: Car sold is the final good flour used by a household is a final good Intermediate goods Intermediate goods are those that are intended for further processing Example: Parts of car are the intermediate good. Flour used by a baker is an intermediate good A. See the following table: Year 1979 1980 1981 1982 1983 1984 1985 1986 Real GDP Growth Rate 1.2% -5.5% 1.8% 3.9% 4.5% 5.3% 2.6% 1.9% a) Calculate the average growth rate from 1982 and 1985. 3.9 %+4.5%+5.3%+2.6% / 4 =16.3% / 4 = 4.0% b) Calculate the average growth rate from 1979 and 1986. 1.2 % - 5.5% +1.8% +3.9%+4.5% +5.3%+2.6%+1.9% / 8 =21.2% - 5.5% / 8 =15.7% / 8 =1.96% 11 P a g e

Question No: 53 ( Marks: 5 ) Why could the world as a whole not experience a problem of a current account balance of payments deficit? The world as a whole not experience a problem of a current account balance of payments deficit because every import to one country is an export from another, and every outflow of investment income or transfer of money from one country is an inflow to another. Thus when all the current account deficits and current account surpluses of all the countries of the world are added up, they must all cancel each other out. Question No: 49 ( Marks: 3 ) Differentiate between real exchange rate and nominal exchange rate. Nominal exchange rate means the number of units of the domestic currency that can purchase a unit of a given foreign currency. For example, 100 Pakistani rupees can purchase one US dollar. If 100 Pakistani rupee can buy two US dollar then we can say there nominal appreciation of the currency. The real exchange rate means how many of a good or service in one country can be traded for one of that good or service in another country. For example, a real exchange rate might state how many Pakistani fans can be exchanged for one US fan. Question No: 52 ( Marks: 5 ) Differentiate between fixed exchange rate and floating exchange rate. Floating Exchange Rate A floating is one where currencies are allowed to move freely up and down according to changes in demand and supply. A currency that uses a floating exchange rate is known as a floating currency Fixed Exchange Rate Exchange rate under which the government or central bank fixed the official exchange rate to another country's currency. Also known as pegged exchange rate. 12 P a g e

Difference b/w Real and Nominal GDP Real GDP: Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. Nominal GDP: Nominal GDP measures the value of all the goods and services produced expressed in current prices. Nominal GDP is measured on current prices for goods and services paid by buyers. Difference b/w demand push inflation and cost push inflation? Cost push inflation Cost push inflation is a phenomenon in which the general price levels rise (inflation) due to increases in the cost of wages and raw materials. Demand pull inflation Demand pull inflation is that occurs when price levels raise because of an imbalance in the aggregate supply and demand. When the aggregate demand in an economy strongly offsets the aggregate supply, prices increase. Economists will often say that demand-pull inflation Differentiate b/w actual GDP and potential GDP Potential GDP The potential GDP of a country is the ideal or maximum possible GDP for that country if unemployment is at a minimum and operating at maximum possible output Actual GDP The actual GDP of a country is the real, or actual, value of all goods and services produced. GDP gap = (Actual GDP potential GDP) / Potential GDP The percentage GDP gap is the actual GDP minus the potential GDP divided by the potential GDP. 13 P a g e

(A) Following are the items of balance sheet of bank A Loans = 80 Deposits = 100 Reserves = 20 Prepare the balance sheet in proper form and find out total assets and total liabilities. Solution: Balance sheet of bank A Assets Liabilities Loans = 80 Deposits =100 Reserves =20 Total assets = 100 Total liabilities = 100 (B) Following are the items of balance sheet of bank A Loans = 60 Deposits = 110 Reserves = 50 Firm A deposits Rs. 50 in bank A. Prepare the balance sheet in proper form and find out total assets and total liabilities after the deposits of firm A. Balance sheet of bank A Assets Liabilities Loans = 60 Deposits =110 Reserves =50 Total assets = 110 Total liabilities = 110 14 P a g e

After deposit 50 Rs Balance sheet of Bank A Balance sheet of bank A Assets Liabilities Loans = 60 Deposits =110 +50 =160 Reserves =50 +50 Total assets = 160 Total liabilities = 160 IF reserve requirement is given then take that % age as reserve P Elastic portion P1 Inelastic portion Q1 Q (A) The above demand curve has two distinct segments which have different elasticities that join to form a corner or kink. Why the firms are reluctant to change the price in these two segments? The firm is reluctant to raise it prices because demand is relatively elastic above the kinked Rise in prices cause fall in sales because other not rise there price and customer switch to lower price products Price increase only decrease the revenue for the firm Firm is reluctant to fall its prices because the demand is relatively inelastic below the kinked. Fall in prices bring only modest increase in sale and other fall there prices too so customer not switch and firm reluctant to fall its prices. (B) What are the major advantages that an oligopoly offers for public interests? Price stability may bring advantages to consumers and the macro-economy 15 P a g e

Question No: 50 ( Marks: 3 ) On what basis countries gain from trade? Countries gains from trade due to the comparative advantage. Countries which have comparative advantage in the production of particular goods exports that good to another country that has comparative disadvantage in that good. Question No: 51 ( Marks: 5 ) A. "Slope of the consumption function is less than 1".What is meant by this statement? The slope is merely the MPC. The intercept is positive because some consumption must happen even at a zero level of income (people will borrow and spend on food for e.g.), and the slope is less than 1 because not all the income is consumed B. What are the major macroeconomic variables involved in the determination of national income? Major macroeconomic variables involved in the determination of national income are C, I, G, X, M, T, S, prices, exchange rate, interest rate and money supply. What does the 45 degree line in expenditure-income space represent? It represents all the points at which the economy is in equilibrium, i.e. the expenditure on domestic goods and services is equal to the supply of domestic goods and services is equal to the incomes distributed to actors used in the production of those goods and services Functions of Central Bank: Monetary policy is just one of the functions of the central bank. There are at least three more functions central banks serves: 1-As lender of last resort, it must bail (or help) out commercial banks facing temporary liquidity shortfalls; 2- as supervisor of the financial system, it must ensure its good health by monitoring commercial banks lending (risk-taking), capital adequacy, and liquidity positions. The central bank is also a monitor of the management and governance of financial institutions and of any other threats to the stability of the financial system; 16 P a g e

3-As the biggest intervener in the foreign exchange market (and/or setter of the exchange rate), it is responsible for exchange rate policy and the balance of payments, per se. Discount rate: the central bank sometimes extends credit to commercial banks on their request to meet their exigent liquidity needs.7 Such borrowing is called borrowing from the discount window and the rate the central bank lends at the discount window is called the discount rate Question No: 49 ( Marks: 3 ) Write down the functions of commercial banks. They take deposits (i.e. borrow money) and make loans (i.e. lend money). The interest rate they pay on deposits is lower than the interest rate they charge on their loans. The difference covers their overhead costs and profits Question No: 50 ( Marks: 3 ) How the growth rate of output is determined in the exogenous growth model? Growth rate of output is determined by the growth rate of population which is exogenously given and Government can not do anything about it. Question No: 50 (Marks: 3 ) Differentiate between international trade and international finance. International trade is the exchange of goods and services between different countries and International finance is concerned with, among other thing, the mobility of financial capital across countries, and the problems and opportunities this mobility presents individual countries with. 17 P a g e

Question No: 50 ( Marks: 3 ) Explain the shape of money demand curve with the help of diagram. i Money demand curve Y - Y L2 L1 L1 L3 L o Money Demand Increase in income by + ΔY cause money demanded to increase at any level of interest money demand curve shift form L1 to L2 Reduction in income by - ΔY money demanded curve shift from L1 to L3 quantity demanded of money fall Question No: 51 ( Marks: 5 ) How can a current account, which is in deficit, be restored to balance under fixed exchange rate regimes? Current account is very much important in order to maintain the long term sustainability of the balance of payment. Current account deficit = Private sector resource deficit + Government budget deficit Devaluation can help in reducing current account deficit. Devaluation causes an increase in exports and decrease in imports leading to reduction in current account deficit. Economic deflation is another solution to this problem under fixed exchange rate regime. 18 P a g e

Question No: 49 ( Marks: 3 ) Mention the transactions that cause the demand for dollars to increase in the foreign exchange market. Pakistani imports of US goods. Pakistani travelers traveling to the US. Pakistani students paying for study in US universities. profits send back to US by US firms operating in Pakistan Differentiate between transaction motive and precautionary motive of holding money. Transactions demand/motive: People hold money to buy stuff. Precautionary demand/motive: People hold money for emergencies Demand for Money Transactions demand. People hold money to buy stuff. Precautionary demand. People hold money for emergencies Speculative demand. People hold money to take advantage of a financial opportunity at a later date Question No: 52 ( Marks: 5 ) What are the major weaknesses of exogenous growth theory? Which theory was developed in against of exogenous growth theory? Exogenous growth theory suffered from three major weaknesses: i. It could not explain why the gap between the poor and rich countries had widened (anticatch up), ii. It could not explain why some countries in East Asia had apparently grown consistently on the back of higher saving rates, and iii. It modeled technology as exogenous, and beyond the influence of policy Endogenous growth theory or new growth theory was developed in against of exogenous growth theory In economics, endogenous growth theory or new growth theory was developed in the 1980s as a response to criticism of the neo-classical growth model 19 P a g e

Question No: 52 ( Marks: 5 ) Identify which of the following are stock variables and which are flow variables? a) Unemployment Stock b) Redundancies (job lay-offs) Flow c) Profits Flow d) A firm s stock market valuation (share price) Stock e) The value of property after a period of inflation Stock Question No: 53 ( Marks: 5 ) World Bank suggests some structural reform policies for the poor countries to grow. Discuss those policies briefly World Bank has given 4 types of liberalization policies as an ingredient. 1. Liberalization of prices: Removal of price control and wage controls. 2. Liberalization of trade: Removal of tariffs and export taxes. 3. Liberalization of capital account means movement of capital from inside and outside the country. 4. Financial liberalization i.e. financial sector should be opened both to foreign participation and also banks should be allowed to set their own interest rate rather than government dictating what the interest level should be. Question No: 49 ( Marks: 3 ) Differentiate between inflation and deflation. Inflation is a situation in which there is a continuous rise in the general price level. Deflation is the opposite of inflation and occurs when the general level of prices falls. Pure inflation is a special case of inflation in which the prices of all the goods and services in the economy are rising at the same rate. 20 P a g e

Question No: 50 ( Marks: 3 ) What are the reasons that poor countries remained poor? OR Do not have enough human capital and because of lack of education Poor countries exports cotton, rice, wheat, raw material which face declining price in international market. Term of trade of developing countries was deteriorating. decline terms of trade They were stuck in the production of primary products Lack of human, social and public capital Very fast rising populations Lack of natural resources (like oil, gold, gas, iron, copper etc What is the reason of poverty in developing countries according to Prebisch-Singer hypothesis? 3 - Marks Reason of poverty in developing countries according to Prebisch-Singer hypothesis They were stuck in the production of primary products Lack of human, social and public capital Very fast rising populations Lack of natural resources (like oil, gold, gas, iron, copper etc.) What are the different method of measuring GDP There are three equivalent ways of measuring GDP: i. The product or value added method which sums the value added by all the productive entities in the economy; ii. The expenditure method which sums up the value of all the final goods transactions taking place in the economy; iii. The factor income method which sums up all the incomes earned by all the factors of production in the economy (rent for land, wages for labour, interest for capital, and equity returns for entrepreneurship). 21 P a g e

Question No: 50 ( Marks: 3 ) What are the different borrowing options available to the government for reducing the fiscal deficit? By borrowing locally (i.e. issuing bonds), foreign financing (including non-relpayable grants) or printing money (i.e. borrowing from the central bank). The first of these methods is least inflationary while the last one is most inflationary Question No: 51 ( Marks: 5 ) Explain the difference between endogenous growth model and exogenous growth model. Exogenous The development of an economy is not only dependent on the internal affairs of a company; rather the external matters also make effect upon it. Under exogenous growth (comprehensive development) it is estimated on the primary basis that which external factors play the role of development of economy in comparison to internal factor Endogenous Endogenous growth (limited development) is a kind of policy under which the emphasis is laid down on the internal process and capital investment rather than external factors. Under this policy, an emphasis is laid down on internal factors for the economic growth and development rather than external factors. Question No: 52 ( Marks: 5 ) What are the conditions in which foreign exchange market exists? Also give some examples of foreign exchange markets. A foreign exchange market exists because economies utilize national currencies. If the world economy used a single currency there would be no need for foreign exchange markets. Foreign exchange market is a market in which currencies of different countries are traded. For example, Foreign exchange markets are made up of banks, commercial companies, central banks, investment management firms etc. The Foreign exchange market is considered to be the largest financial market in the world. 22 P a g e

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